Stock & Bond Funds

Just under half of the $12.08 trillion in total mutual fund assets at the end of November 2007 were invested in stock funds, according to figures from the Investment Company Institute.

If you add another $1.678 trillion in bond funds and $718.9 billion in hybrid funds, you can see that stock and bond funds comprised about 74.5% of total mutual fund assets. Hybrid funds invest in both stocks and bonds or have similar characteristics that make it hard for the fund to be described as one or the other.

As mutual fund investors change their allocations to stocks and bonds over the course of an economic cycle, the respective share of investments in stock, bond and money market funds changes.

There are different ways of slicing and dicing stock and bond mutual funds. Funds are sometimes categorized by their investment objective or investment style. Investment objective identifies the types of investments a mutual fund buys. Investment style is a narrower distinction that distinguishes a fund's selection of individual securities and trading rules.

You can find a fund's investment objective and investment style in its prospectus. You should always read a fund's prospectus before investing in the mutual fund.

In this topic, we look at how the ICI and major fund rating services categorize stock and bond funds, starting with stock funds.

The ICI categorizes hybrid funds as either asset allocation, flexible portfolio, income mixed, or balanced funds.

Morningstar and Lipper, the two major fund-rating services, divide stock funds into broad categories and then subdivide those into subcategories.

Morningstar divides its stock funds into domestic and international categories. The Chicago-based company divides its domestic funds into nine main fund categories: large-, mid- and small-cap for growth, value and blend investment styles.

Lipper, a subsidiary of U.K.-based media firm Reuters PLC, categorizes stock funds as either diversified or specialized. Then, it divides diversified funds by the market capitalization of stocks the fund invests in: large-, mid-, small- and multi-cap. To obtain a set of 12 main diversified stock funds, it further divides each of the market caps into investment styles of growth, value and core.

In addition to these main 12 funds, Lipper has another seven or so categories of diversified funds, including balanced and income funds. Its specialized funds include about 20 subcategories, including country, sector, regional and international funds.

Index funds invest in a basket of stocks that mirrors the composition of a popular stock index. The S&P 500 is one of the most popular benchmark indexes. Index funds offer diversification, lower transaction costs and generally pay out less in capital gains taxes. If an index fund is constructed from a large-cap index (such as the S&P500), it will fall under the large-cap categories. If it is constructed from a small-cap index (such as the Russell 2000), it will fall under the small-cap categories.

Let's turn to categories of bond mutual funds.

The ICI divides bond funds into taxable and tax-exempt funds. Taxable bond funds include fund categories that invest in corporate, high yield, international, mortgage-backed, and government bonds. Four of these categories are further divided into categories that are based on the maturities and types of securities held in the fund's portfolio.

Tax-exempt bond funds include state and national municipal bond funds. Each of these categories is further divided based on the average maturity of bonds held in the fund's portfolio.

Lipper categorizes bond funds as investment-grade, high yield, corporate, municipal, government and international funds. These six categories are further divided into more specialized categories such as high-yield muni bonds and intermediate-term investment-grade bonds. The Wall Street Journal displays a dozen or so of Lipper bond indexes based on these categories.

Morningstar divides its bond funds into taxable and municipal bond categories. Its taxable bonds are largely divided into categories of government and corporate bonds that are further divided by the average maturity of bond held in the fund's portfolio: short-, intermediate- and long-term. Other major taxable-bond categories include high yield, international and emerging markets.

Morningstar's municipal-bond categories include national and state muni bond funds, further divided by average maturity of the fund's portfolio. To accommodate muni bond investors in high-income tax states, Morningstar offers muni bond categories for California and New York muni bond funds.